Chief Investment Strategist
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We believe our present asset allocation still appropriately ranks return opportunities
The Citi Private Bank Global Investment Committee left its asset allocation unchanged at its meeting on 24 January. Global equities remain 4% overweight, with US equities remaining at a full (neutral) allocation. Fixed income remains 4% underweight, with developed markets bonds apart from the US comprising the largest underweight. US high yield, Emerging Markets (EM) local and hard-currency bonds remain overweight.
With bond markets under pressure, our asset allocation has performed strongly in the past several months. The strength of equity market gains of late is diminishing their future returns. Nonetheless, we believe our present asset allocation still appropriately ranks return opportunities.
An improving global growth outlook still favors equities relative to unusually expensive developed markets bonds. With US corporate tax cuts now in place, US EPS should rise 14-15% in 2018, largely justifying the rise in US equities over the past year. The second order impact of stronger, sustained growth seems likely to power further gains. Both the 4Q 2017 and 1Q 2018 corporate earnings reports should inform our views of the return outlook for the year.
Financial market seasonality strongly favors positive early year returns in risk assets. Following this impact, intra-year weakness may occur. Financial market volatility should be rising from historic lows for several reasons.
Signs of excessive financial exuberance can be seen in the vast and growing numbers of cryptocurrencies. Collectively these now eclipse the value of bitcoin, exceed the number of government issued currencies, and have a highly questionable future value. As noted some months ago, low correlations between asset prices are also a sign of “bull market psychology.” This benefits near-term returns at the expense of the future.
Nonetheless, amid a strengthening global growth outlook and unusually large divergences in many asset values, we see a generally good environment for generating returns. We continue to favor Emerging Market equities, which are merely in line with their long-term valuation. European equites (ex-UK) boast near 4% dividend yields with undemanding valuations. EM and high yield US bonds show attractive yields relative to DM government bonds. Master-Limited Partnerships have significantly lagged behind the value of other energy assets, and also deserve an allocation for suitable investors.
In the coming months, if Federal Reserve tightening expectations accelerate, a counter-trend rebound in the US dollar could occur. This may challenge our EM allocations and global equities in general. We will assess our asset allocation with this risk - and countervailing earnings gains, in mind.
Notably, our strategic (10-year) return estimates for EM equities are the highest in public markets. We would note the significantly lower correlation between EM equities markets compared to DM equities in key regions. Our favored EM equity region remains Asia, while LATAM is somewhat more promising for fixed income prospects (please see our Outlook 2018 report for more).